It can be easy to underestimate the impact of trader psychology on investing.
The psychological baggage that follows in the wake of a bad portfolio can have a devastating influence on a trader’s ability to continue in the market.
So much so, that history often shows that the big money is made by new entrants to the market that do not have the legacy of major drawdowns.
When investors take severe blows to their performance and confidence, losses can be rationalized with excuses that things will recover in the next bull market.
Yet the reality is, sometimes stocks never recover, and this loss of confidence can see traders sitting on the sidelines, missing out on all of the best opportunities. Ultimately, resulting in even further underperformance.
Some of the best and most experienced investment managers in the world have figured out over time that when team members go through a pattern of losing money, it is very difficult for them to then make incrementally good decisions. As a result, they have dynamic systems to move capital away from those who are psychologically not in an ideal place to perform, shifting it to those who are performing well.
As individual investors don’t have the luxury of passing responsibility to another trader, their performance is all that matters. They must be their own risk manager and recognize when their psychology is causing poor decisions.
In any slump, there is a range of steps a trader can take to help break the cycle. From completely taking a break from trading to implementing a routine of relaxation before and during sessions. It is also an opportunity to look back on one’s strategy including reviewing and reinforcing the patterns associated with their previous success. Finally, as difficult as it is, it may be necessary to moderate capital at risk by reducing position sizes, in order to preserve good long-term performance.
Doing so, gives investors the chance to keep their risk in check, and regain the confidence they need to focus on the opportunities that they should.